VERIFICATION AND VALUATION OF ASSETS AND LIABILITIES Contents:

Concept of verification Objective of verification Scope of verification Advantage of verification Techniques of verification Verification of assets Difference between vouching and verification

Introduction Spicer and Pegler have defined verification as “it implies an inquiry into the value, ownership and title, existence and possession and the presence of any charge on the assets”. Verification is a process by which an auditor satisfies himself about the accuracy of the assets and liabilities appearing in the Balance Sheet by inspection of the documentary evidence available. Verification means proving the truth, or confirmation of the assets and liabilities appearing in the Balance Sheet. Thus, verification includes verifying:- 1. The existence of the assets 2.Legal ownership and possession of the assets 3.Ascertaining that the asset is free from any charge, and 4.Correct valuation Of course it is not possible for the auditor to verify each and every asset. It was held in Kingston Cotton Mills case that “it is not part of an auditor’s duty to take stock. No one contend that it is. He must rely on other people for the details of stock in trade in hand”. However, as per the decision given in Mc Kesson and Robins case (1939) the auditor must physically inspect some of the assets. Now the auditor has to

report whether the balance sheet shows true and fair view of the state of affairs of the company. Hence, he is required to verify all the assets and liabilities appearing in the balance sheet. In case of failure, the auditor can be held liable for damages. According to the `statement of auditing practices’ issued by ICAI, “the auditor’s object in regard to assets generally is to satisfy that :- 1. They exist. 2. They belong to the client. 3. They are in the possession of the client or the persons authorized by him. 4. They are not subject to undisclosed encumbrances or lien. 5. They are stated in the balance sheet at proper amounts in accordance with sound accounting principles, and 6. They are recorded in the accounts. While conducting verification following points should be considered by the auditor:- 1. Existence: The auditor should confirm that all the assets of the company are physically existing on the date of balance sheet. 2. Possession: The auditor has to verify that the assets are in the possession of the company on the date of balance sheet. 3. Ownership: The auditor should confirm that the asset is legally owned by the company. 4. Charge or lien: The auditor has to verify whether the asset is subject to any charge or lien. 5. Record: The auditor should confirm that all the assets and liabilities are recorded in the books of account and there is no omission of asset or liability. 6. Audit report: Under CARO the auditor has to report whether the management has conducted physical verification of fixed assets and stock and

the difference, if any, between the physical inventory and the inventory as per the book. 7. Event after balance sheet date: The auditor should find out whether any event after the date of balance sheet has affected any items of assets and liabilities. SCOPE OF VERIFICATION Verification includes information on the following:- 1. That the assets were in existence on the date of the balance sheet 2. That the assets had been acquired for the purpose of business only 3. That the assets had been acquired under a proper authority 4. That the right of ownership of the assets vested in the organization 5. That the assets were free from any charge and 6. That the assets were properly valued and disclosed in the balance sheet. OBJECTS OF VERIFICATION: Following are the objects of verification of assets and liabilities 1. To show correct valuation of assets and liabilities. 2. To know whether the balance sheet exhibits a true and fair view of the state of affairs of the business 3. To find out the ownership and title of the assets 4. To find out whether assets were in existence 5. To detect frauds and errors, if any 6. To find out whether there is an adequate internal control regarding acquisition, utilisation and disposal of assets. 7. To verify the arithmetic accuracy of the accounts 8. To ensure that the assets have been recorded properly.

ADVANTAGES OF VERIFICATION Advantages of verification are as under:- 1. It avoids manipulation of accounts 2. It guards against improper use of assets 3. It ensures proper recording and valuation of assets 4. It exhibits true and fair view of the state of affairs of the company. TECHNIQUES OF VERIFICATION: 1. Inspection: It means physical inspection of the assets i.e. company cash in the cash box, physical inventory, inspection of shares certificates, documents etc. Inspection provides reliable audit evidence about the existence of the tangible assets inspected but not necessarily as to the ownership or value of such assets. It involves examining records, documents or tangible assets and provides audit evidence of varying degrees of reliability depending on their nature and source and the effectiveness of internal controls over their processing. Inspection also provides three major categories of documentary audit evidence, listed in ascending degree of reliability, viz: (a) Evidence created and held by the entity; (b) Evidence created by third parties and held by the entity; and (c) Evidence created and provided to auditors by third parties 2. Observation: The auditor may observe or witness the inspection of assets done by others. The auditor, by observation, looks at a procedure being performed by others, for example the auditors observe the counting of stock by the entity’s staff or the performance of internal control procedures as part of the conduct of an audit. 3. Confirmation: It means obtaining written evidence from outside parties regarding existence of assets. Confirmation involves obtaining response to an enquiry to corroborate information previously made available to the auditors in the course of the audit. Examples of direct confirmation are as follows:

(a) Confirmation of debts by communication with debtors; (b) Confirmation of legal cases by communication with the entity’s solicitors; and (c) Confirmation of bank balances by communication with the entity’s bankers. VERIFICATION OF ASSETS AND LIABILITIES Share Capital Share Capital When there are new issues Share capital is a special sort of liability of a company. When share capital has been issued during the year, auditors should: (a) Ensure that the issue is within the limits authorised by Memorandum and Articles of Association of the entity; (b) Ensure that the issue was subject to directors’ minutes and shareholders’ approval, where applicable; (c) Ascertain and evaluate the system for the control of issue; and (d) Verify that the system has been properly operated. This will involve examining the prospectus (where applicable), application and allotment sheets, the share register, cash received records, share certificate counterfoils, and refunds to unsuccessful applicants. Where Stock Exchange approval was required, the auditors should: (a) Ensure that permission has been obtained. If it has not been given all the money subscribed is returnable; (b) Ensure that all the money is maintained in a separate bank account until all conditions were satisfied; (c) Ensure that the minimum subscription has been received. If there are not enough subscribers then the whole amount is returnable; and (d) Vouch the payment of underwriting and other fees. Where there are no new issues When no new issue of shares has been made, the auditor should: (a) Determine the total of shares of each class as stated in the balance sheet and obtain a list of shareholdings, which in total should agree with the balance sheet total; (b) Test the balances in the share register with the list; (c) If this is not possible at the balance sheet date, it may be permissible to do

it earlier provided that the auditor is satisfied with the system of control over transfers; and (d) Where the share register is maintained by an independent firm of registrars, the auditor should obtain a certificate as to the accuracy and completeness of the shares and their holdings. The certificate should state that the balances on the share registers agree with the issued capital at the balance sheet date. Loans advanced Loans may of different types like : (a) Loans against the security of land and buildings. (b) Loans against the security of goods (c) Loans against the security of stocks and shares. (d) Loans against the security of insurance policies, and (e) Loans against the personal security of the borrower. Therefore, in each case, the duty of auditor in general is as under: 1. Verify whether object clause of the Memorandum provides for granting of such loans. 2. Examining whether a proper loan ledger has been maintained and it is up-to-date or not. 3. Examination of the security lodged against each loan. The loan agreement is to be scrutinized regarding the rate of interest.Due dates of instalment, penalty, interest, etc. 4. He should ascertain whether any loan is doubtful of recovery in which case a provision for the expected loss is to be made. 5. Except in case of a banking or finance company, auditor has to ascertain whether the purpose of advancing is connected with business or not. Section 227(4A) of the Companies Act, 1956 requires an auditor to report whether the parties to whom the loans are given are regular in payment of interest and principal and the terms of the loan are not prima facie prejudicial to the interest of the company.

(a) Loans against the security of Land and building 1. The auditor has to examine the mortgage deed, see if the copy has been properly executed and registered in favour of the client. 2. The auditor has to examine the title deeds deposited with the mortgage deed. 3. The auditor, if required, has to examine the valuer’s certificate in order to ascertain the value and sufficiency of the security. 4. The auditor has to confirm that the property is properly insured and insurance premiums have been paid in time. 5. The auditor has to examine the title of the Borrower to the property, etc. 6. If the mortgage is a second mortgage, the auditor has to confirm that the same is brought to the knowledge of the first mortgagee. In this case he has to take the acknowledgement of title deeds from the first mortgagee. (b) Loans against the security of goods. 1. The auditor has to examine the nature of the goods and confirm that the goods are really belonging to the borrower. He should see whether the loan is granted against railway receipt, lorry receipt, dock warrant, Godown keeper’s receipt etc. 2. In case goods are stored in the godown, he has to see that the rent of the godown is paid in full and the goods are fully insured. 3. The auditor should examine the value of the goods by comparing them with the present market value. Regarding quality and quantity, he may rely on the inspector’s reports. 4. If the goods are of perishable nature, the auditor has to examine the turnover of the stock of the client. (c) Loans against the security of stocks and shares

1. He should call for a statement of stocks and shares given as security and confirm that all of them are fully paid up. 2. He should see whether an instrument of transfer is properly stamped and is properly executed. 3. He should see that their value is properly disclosed as per the prevailing market rates. 4. He has to ensure that there is a sufficient margin on the loans advanced. 5. He has to see whether the charge is properly registered or not. (d) Loans against the security of insurance policy: 1. The auditor should see that the policy has completed at least two years. 2. The auditor should confirm that all the premiums have been properly paid and the policy is in force by examining the latest premium receipt. 3. The auditor should ascertain that due notice of assignment has been given to the insurance company. 4. The auditor should see that the loan has been advanced on the basis of surrender value of the policy as certified by the insurance company. 5. The auditor has to ensure that the premium, if any, paid up by the lender to keep the policy in force is properly debited to the Loan Account of the borrower together with the usual interest. (e) Loans against the personal security of the borrower The auditor has to examine the documents like Promissory Note, Guarantor’s details and Salary Certificate of the borrower, etc. Sundry Debtors: Sundry Debtors represents the amount recoverable from the customers for sale of goods or rendering of services. 1. The under mentioned procedure should be applied for verification of `Book Debts’ or `Sundry Debtors’ after receiving a schedule or list of debtors from the client.

(a) Direct confirmation of balances from debtors by sending confirmatory letters. (b) Year-end Scrutiny of ledgers. (c) Verification of the position of debts considered bad or doubt ful. (d) Compliance with legal requirement or presentation. 2. The auditor should arrange to send the letter of confirmation of balances by the client as per client’s records and see that the reply of confirmation is forwarded to his office directly. Usually this should be sent within 15 or 20 days of close of the year under the supervision of the audit staff. After the reply is received, the same should be tallied with the balances shown in the Debtors Ledger and difference properly reconciled. 3. After the said procedure is carried out, he should carry out a thorough scrutiny of the debtor’s individual accounts. Wherever the number of debtors is very large, Test Checks can be applied. 4. While scrutinizing the ledger, the auditor should focus the light on discounts, returns, cash received, rebates allowed, goods returned etc. 5. On ascertaining the balances of the debtors as genuine and correct, the auditor has to verify the debtors to find out bad or doubtful debts to make a provision for the same. If the debts are bad and irrecoverable or doubtful and they are not provided for properly, the financial statements will not portray a `True and Fair’ view. Hence, appropriate provision is to be made by considering the age of the debtor, scrutiny of payments received, management opinion and any other information like financial position of debtors, etc. If the auditor fails in verifying the appropriateness of the provision made, he shall be held liable for negligence. 6. After ascertaining the position of bad or doubtful debts, he should see that the legal requirements of Schedule VI to the Companies Act, 1956 are complied with. For this purpose, the debtors are to be classified as: (a) Outstanding for a period of more than six months; and (b) Other debts.

7. Over and above this, other requirements like debts considered as good and which are fully secured, debts due from the officers, directors, managers of the company, etc., are to be ascertained for disclosure. 8. If the customers have purchased the goods on hire purchase system and some of the instalments are not due, the same is not to be shown as `stock out on hire purchase’. 9. Likewise, if the goods are sold on `return or approval’ basis, such customer cannot be shown as a debtor at the close of the year. 10. Further, whenever there are credit balances in some debtors account, the same are not to be deducted from other debtors debit balances and net balance is not to be shown in the assets side, but former is to be shown as Sundry Creditors. Valuation of Inventory Generally accepted accounting principles require that inventories be reported at the lower of historical cost or market (current replacement cost), provided that the carrying value should not exceed net realisable value (estimated selling price minus costs of completion and disposal) or be lower than net realisable value reduced by the normal profit margin. To achieve the valuation objective for inventories, the auditor should test the inventory costing. In addition, he should: (a) Review and test procedures for identifying obsolete or slow-moving items; (b) Review the costing of damaged or obsolete items to determine that the assigned value does not exceed net realisable value; and (c) Review and test the determination of market prices to determine whether market value is lower than cost. The auditor should: (a) Consider not only finished goods but also work in process and raw materials that will eventually become finished goods in the review for obsolete items; (b) Compare quantities with those in previous inventories on test basis to identify slow-moving items or abnormally large or small balances; and (c) Reviews of usage records can provide further indications of slow-moving items.

If the client does not maintain perpetual records, the auditor may examine purchase orders or production orders to determine how recently certain items of inventory were acquired. Many companies have formulae or rules of thumb that translated overall judgements on obsolete stocks into practical detailed applications, for example: (a) All items over a year’s supply; (b) All items that have not moved within six months; and (c) All items bearing certain identifying numbers with regard to date or class of product. The auditor should review whether the rules are realistic and comprehensive enough as well as whether they are fully and accurately applied. In addition to reviewing and testing the client’s rules, the auditor must evaluate, based on an understanding of the client’s business climate, whether inventory can be realised in the normal course of operations. Past experience can be a good guide to the net realisable value of items that must be disposed of at salvage prices. When certain finished goods are declared obsolete or severe markdowns are required, consideration should be given to related raw materials and work-in process inventories write down. Patent and Trademarks: 1. The ownership of patent rights is verified by inspection of certificate issued for grant of patent, by the prescribed authority. 2. If it has been purchased, the agreement surrendering it in favour of the client should be examined. 3. If there are a number of patents held by the client, obtain a schedule giving the full details thereof or verify with reference to the register maintained by the client. 4. It must be verified that patent rights are alive and legally enforceable and renewal fees have been paid on due dates and charged to Revenue Account. The last renewal receipt should be examined to ascertain that the patent has not lapsed.

5. See that the patents are properly registered in the name of the client only. 6. See that the cost of patent is being written off over its useful period of life. 7. In case the patent is acquired, cost paid for the same and all relevant expenses are to be capitalized. 8. If the patent is created by the client by the research experiments and laboratory work, only the actual expenses incurred for it in the process are to be capitalised. Copyrights 1. The auditor has to examine the written agreement of assignment along with the royalty paid to the authors etc., for such copyrights. 2. He has to see that such assignments are properly registered. 3. If the client is the owner of many copyrights, the auditor should ask the client to prepare a schedule of copyrights and get the detailed information to confirm that the same is shown in the Balance Sheet. 4. Regarding the value of copyrights, it should be remembered that this asset has no value in the long run. Hence, value is determined on revaluation basis and period of copyrights. 5. If any copyright doesn’t command the sale of any books, then the same should be written off in such year. The auditor has to verify the same in detail. Investments: Investment may be a share certificate, government bond certificate, government loan certificate, debenture certificate, etc. For verification of such securities, the following procedure is adopted. 1. Obtain a schedule of investments in hand at the beginning of the audit period. Obtain the details of description of investments together with distinctive number of face value, date of purchase, book value, market value, rate of interest, date of payment of interest or, date around which dividend is declared, etc., with also the details of interest or dividend received along with tax deducted at source.

2. Add to the above list, purchase made during the year and delete the investments sold during the year with all the above details. 3. Balance this schedule and compare the balance with general ledger and Balance sheet. 4. Check the market value of investments with reference to stock exchange quotations or other suitable method, on Balance Sheet date and see that the values are disclosed in the Balance sheet. 5. Inspect the certificates or securities physically on the Balance Sheet date. 6. Compare the income received with amount due and adjust the accrued income. 7. Confirm the uncalled liability on partly paid shares held as investment shown as contingent liability by way of a note to the Balance Sheet. 8. See that adequate provision is made for any shortfall in the book value of investment shown in the Balance Sheet. 9. See that, regarding the investment in subsidiaries, disclosure requirement of section 212 of Schedule VI of the Companies Act, 1956 are complied with. 10. For investment in the capital of partnership, the partnership deed and copy of accounts of partnership firms, is to be verified. Also adjust the share of profit and loss for the partnership period. 11. Investments which stand in the name of persons other than that of the company are to be confirmed with appropriate sanction. 12. For investment lodged with others as security or lying with banks or share brokers, obtain a certificate from the parties concerned. 13. In case of application money paid for shares which are still to be allotted, that fact is to be specially disclosed in the Balance Sheet. Goodwill 1. Whenever the company has purchased or acquired a running business and has paid for it an amount, in excess of the book value of its net assets, the excess is called `Goodwill’. It can be verified from the vendor’s agreement and

the auditor has to see whether there is a specific sum which is paid or whether it is the excess of price paid over the tangible assets and see that it is properly recorded. 2. When the company has written up the values of all its assets on a revaluation and has raised a Goodwill Account in the books, the Goodwill appears in the Balance Sheet. In this case, the auditor has to see the basis of valuation and get satisfied about the same. If he is not satisfied, the fact should be reported to the shareholders. 3. He has to see that such excess is credited to a Capital Reserve or Revaluation Reserve and no dividend is being declared from it. 4. He has also to see the disclosure requirement of Schedule VI and ensure that the fact are disclosed for 5 years subsequent to the date of revaluation. 5. Sometimes, Goodwill which is written off earlier may be brought back in the books of account to adjust the debit balance of Profit and Loss account. In this case, the auditor should investigate the fact and satisfy in full before approving such method of creating Goodwill. He should also refer to the board resolution. In case he is not satisfied, the fact should be reported to the shareholders. 6. If Goodwill has been created by any other means, the auditor should see that all relevant facts are properly disclosed and are supported by documentary evidence. Plant and Machinery: 1. Now-a-days as per provision of Section 227(4A) of the Companies Act, 1956 every company is required to maintain a Fixed Asset Register showing full particulars including cost, location, depreciation, details of purchase, expenses capitalised, etc. Therefore, the auditor should ask for such a register maintained by the client and see that all items of plant and machinery are recorded properly giving full details. 2. As per the provision of the same section, all fixed assets are required to be physically verified by the management. Therefore, the auditor should enquire whether such physical verification was undertaken or not. If yes, he should ask

for necessary papers pertaining to the same. If there is any discrepancy, reasons for the same should be asked. 3. Any new purchase made during the year are to be verified with reference to purchase invoice and other papers regarding installation of the same. 4. Total value of plant and machinery as shown by Fixed Asset Register should tally with ledger account maintained in the financial books. 5. Where any item of plant and machinery is sold, scrapped or transferred the auditor should check relevant entries for the same and verify that they are removed from the Fixed Assets Register. 6. The auditor should verify that adequate depreciation is provided on all items of plant and machinery and method of depreciation is consistently followed from year to year. 7. Auditor should see that the entire plant and machinery stands in the name of the client and are free from any charge or encumbrances. If plant and machinery is mortgaged, then he has to verify that the documents are properly executed and mention of mortgage is made in the Balance Sheet. Freehold Property (Land & Buildings): 1. The auditor has to examine the title deeds of the property owned by the client and confirm that the same is freehold. 2. If the property has been purchased during the year, the auditor has to examine the correspondence with the broker, or solicitor in details. 3. When a building has been constructed on the freehold property, the same is to be verified from builder’s bill or architect’s certificate. 4. Where the title deeds are deposited with the mortgagee on a mortgage, then a certificate from him to that effect is to be obtained for verification. 5. If the title deeds are deposited with the bankers or solicitors for safe custody, the auditor should get a certificate from them to confirm the fact. 6. If required, the auditor should ask the solicitor of the client to confirm the validity of the title deeds relating to the property.

7. The auditor has to see that the conveyance of the property is in the name of the client and the same is properly registered. 8. The auditor has to ensure that the property is properly insured. 9. The auditor should see that separate account for land and building is maintained, because on land, usually no depreciation is provided. 10. In case there is appreciation of land and buildings value by revaluation, the auditor has to see the basis of revaluation and confirm that the same is properly disclosed in the Balance Sheet, to comply with the generally accepted accountancy principles and also the provision of Companies Act, 1956. Preliminary, Expenses 1. These are the expenses incurred for creating or incorporating a company i.e. legal expenses for drafting Memorandum of Association, Articles of Association, Stamp fees, etc. 2. Auditor should check the prospectus or the statement in lieu of prospectus for amount of preliminary expenses. 3. Contract with promoters, vendors, underwriters should be checked. 4. Board of Directors authorization for payment of expenses should be checked. Receipts should be obtained for payments. 5. Actual expenditure for preliminary expenses should not exceed amount mentioned in prospectus or statement in lieu of prospectus. Such excess should be approved by shareholders in general meeting. 6. Preliminary expenses can be written off against Share Premium Account (Section 78), if any. 7. Preliminary expenses should be written off in a reasonable number of years (usually 3 to 5 years). 8. Preliminary expenses to the extent not written off should be shown under Miscellaneous Expenditure, on the Asset side of the Balance Sheet. 9. Preliminary expenses written off during the year should be shown separately in the Profit & Loss Account.

Trade Creditors: 1. The auditor should ask for a schedule of creditors and check the same with the purchase ledger as that is already examined by him. 2. He should ensure that all purchase made during the year especially at the end of the year are included in the accounts of the creditors. 3. In case of suspicion about any creditors, the auditor with the consent of the client can ask the statement of account to be sent and verify the same by scrutinizing ledger accounts. 4. He should see the various debts given for discount, goods returned etc, and confirm that the same are genuine. 6. The auditor should ask for the reason for not paying any overdue creditors. DIFFERENCE BETWEEN VOUCHING AND VERIFICATION Point of Difference Vouching Verification 1. Meaning 2. Nature & Purpose 3. Time 4. Utility 5. Personnel

The act of examining the vouchers is known as vouching. A voucher is any documentary evidence in support of a transaction entered in the books of account. Vouching involves establishing the arithmetical accuracy and the authenticity of the transactions of a concern. Vouching proves that an asset ought to exist. It is done during the whole year. Certifies correctness of records. It is done by the junior staff of the auditor under the supervision of a senior person

Verification can be explained as establishing the truth or securing some kind of confirmation with respect to the assets and liabilities appearing in the Balance Sheet of a concern Verification goes beyond vouching. It seeks to establish that assets as stated in the Balance Sheet of a concern exist in fact and that the liabilities are properly disclosed. Verification proves that an asset does exist. It is done at the end of the year. Certifies correctness of assets and liabilities. It is done by the auditor himself assisted by senior